Reference no: EM131714332

Case -

You are the Chief Financial Officer (CFO) for Zen Distributors, Inc., a media broker that secures shelf space in independent bookstores for small publishing companies. As a member of the company's executive team, you are preparing the operating budget for the fourth quarter of 2017. Your intent is to summarize the budget for team members and provide them with detailed schedules that support your overview.

Zen's general ledger provides you with current account data on September 30, 2017 (the end of the third quarter) of operations:

Accounts (account amounts in thousands of dollars)	Debit	Credit
Cash	$    8,000
Accounts receivable	20,000
Inventory	36,000
Buildings and equipment, net of depreciation	120,000
Accounts payable		$  21,750
Common stock		150,000
Retained earnings		12,250
Totals	$184,000	$184,000

Jack Closer, Vice President of Sales, estimated that sales should increase slightly from their fourth quarter levels of the previous year.  Per your request, he forwarded his monthly fourth quarter sales estimates to you, along with the current month's actual sales and his forecast for January 2018.

Month	Sales
September (actual)	$  50,000
October	60,000
November	72,000
December	90,000
January 2018	48,000

You next met with Mary Balance, Zen's Controller. Ms. Balance informed you that the company prices its products in order to ensure a 25% gross profit margin on sales. Zen has met that margin throughout the first three quarters of 2017, and she was confident that the firm would meet this target margin in the near term.  Mary also told you that, on average, 60% of Zen's customer pay in cash. Those customers receive a one percent discount on the invoice price.

The remaining 40% of the customers pay on account. Credit sales terms are n/2EOM. This means credit customers must pay the full invoice price by the end of the month following the month in which they purchased merchandise. Mary explained, "Our customers are pretty sophisticated, and they constantly manage their cash flows--just as we do. Consequently, if we make a credit sale in October, they will pay us by the end of November." Finally, Mary said, "We screen our customers very carefully before extending them credit. Our customers pay what they owe us. We don't have any bad debts, and we don't expect any in the future."   

Mary also provided you with third quarter monthly expense data to assist in constructing your budget.  The next table presents that information:

Monthly Expense Item	Amount
Administration	$2,500
General	6% of sales
Commissions	12% of sales
Depreciation	$850

She concluded that, "As you know, we pay our operating expenses in the month we accrue them."

Procurement officer Jim Washburn managed inventory so that its ending balance equaled 80% of the next month's cost of goods sold. He also stated that the accounts payable clerk pays one-half of each month's inventory cost in the month of acquisition, and the remaining 50% in the following month. 

Ashleigh McNamara, head of capital expenditures, informed you that Zen will make a cash purchase of $1,500 worth of hand-held scanning devices in early October. Per corporate policy, the firm will depreciate this equipment over thirty months on a straight-line basis. Ashleigh added, "They'll be useless at the end of that time, so we will scrap them." 

In your role as CFO, you insist that Zen maintain an ending monthly cash balance of $4,000 in order to remain financially flexible. The company has an open line of credit with its banking partner to ensure that it can meet its cash balance goal. This agreement mandates a 12% annual interest rate for all short-term borrowings. Financing must take place at the beginning of the month in thousand dollar multiples. Repayments of borrowing must also occur in thousand dollar increments, and the bank only accepts interest payments when Zen repays principal.     

Required: Compose a memorandum to Zen's management team that highlights the key aspects of the 2017 fourth quarter operating budget. Supplement your summary with budgetary schedules and attach them to the executive summary. The budgetary flow that you select is as follows:

• Cash collections
• Inventory purchases
• Cash disbursements for purchases
• Cash disbursements for operating expenses
• Overall cash budget (collections, disbursements, and financing)

You construct each of the above budgets on a monthly and quarterly basis.  You may find it beneficial to construct your budgetary schedules in the manner presented in this chapter.

Finally, you conclude your budgets with a projected (pro-forma) income statement for the fourth quarter and a pro-forma balance sheet as of December 31.  The company has a zero percent income tax rate, due to previous tax losses.